Setting prices is not easy. Unfortunately many small businesses do not spend adequate time on setting their pricing. As a result, most businesses under-price their goods and services. This can be a risky proposition – if your price is too low, you may invite consumer skepticism. However, swing too far to the high side, and you will frighten away buyers.
There is no single method to determine pricing; however when doing so one should consider sales volumes, competitor’s prices, and your competitive advantage. In product pricing, you need to know what your break-even point is and how to calculate it for every product or service you provide. Break-even is the key to determine whether you are making money or not. It is vital for a start-up to know when you hit break-even volume. (See our February newsletter in our archives to learn about calculating break even)
What many businesses fail to do is factor into their pricing both variable and fixed costs. Fixed costs do not change with varying quantities of sales, and include such items as management salaries, rent, taxes, telephone, utilities, equipment repairs and maintenance, and depreciation (often forgotten!). Variable costs vary directly with production or sales, and include items like materials for manufacturing, wholesale costs for retail, transport/shipping, direct labour, or marketing (e.g., variable commissions).
Once both fixed and variable costs per unit are known, a suitable mark-up (profit) is added, and will depend on: a) competitiveness of your industry; b) if your product is a luxury or necessity; and c) your amount and cost of capital.
Most small businesses don’t have a proper pricing system. Don’t be one of them. Once you understand your costs, you can use this information to improve profits. You’ll know where you can selectively raise prices, where freebies can be eliminated (e.g. delivery), and price discrimination (e.g. advance or last minute airline bookings). Most importantly, you’ll know where you make money.
For more information, contact us at 204-478-7266 x110.
|This article originally appeared in the July 2011 edition of The Beal Business Advisor. The issue also included:
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